Employers will overlook bad credit

Employers increasingly screen job applicants by using credit reports, among other ways. That could deny jobs to those who most need them, by turning yesterday’s financial problems into today’s handicap in the employment market. Legislation prohibiting employers in the United States from requesting potential hires to disclose their credit history has been circulating in Congress. And some US state legislatures have already passed laws restricting the use of employer credit checks.

However, research by Princeton University’s Will Dobbie, Federal Reserve Bank of New York’s Paul Goldsmith-Pinkham, Chicago Booth’s Neale Mahoney, and the Social Security Administration’s Jae Song finds that the use of credit reports doesn’t have a measurable impact on hiring, as the credit report is just one of a broad range of data inputs employers rely on.

The researchers examine the impact a bad credit report has on a person’s financial and labor-market outcomes. The Fair Credit Reporting Act of 1970 limits the length of time bankruptcy information can be stored on credit reports. Under the FCRA, Chapter 7 bankruptcies are removed from credit reports 10 years after the date of adjudication, while Chapter 13 bankruptcies are removed after seven years. Using data from the Federal Reserve Bank of New York and the Social Security Administration, the researchers compare Chapter 13 filers who have their bankruptcy flags removed at seven years with Chapter 7 filers after the same amount of time.

The data reveal that removing the bankruptcy flag led to an immediate increase in credit scores for Chapter 13 filers and to immediate positive effects on credit-card and mortgage borrowing. “There is an economically and statistically significant impact of flag removal on both credit card limits and balances that grows fairly linearly over time,” write the researchers. Removing flags significantly affected the probability of filers having at least one mortgage as well as the aggregate balance of their mortgage debt, the two measures the researchers use to assess the level of mortgage borrowing.

In stark contrast, Dobbie, Goldsmith-Pinkham, Mahoney, and Song find that removing a bankruptcy flag had no significant effect on labor-market outcomes, including employment and wage earnings.

Could the overall findings mask large effects for unemployed people, or others on the margin of the labor force? To find out, the researchers created variables to look at people who had changed jobs, kept the same jobs, or left their jobs, and who had stopped or started working. They find no economically significant effects on any of these variables. ​

Credit reports are most useful in lending scenarios, where they act as the main information source lenders use to screen people applying for credit cards or mortgages, the researchers find. But for employers, who have other information such as past work history to consider, credit reports matter less.